Posts Tagged ‘ETF’

Leveraged ETF’s in the News – Wall Street Journal

July 23, 2009

I continue to be concerned about the use of leveraged ETF’s by retail clients. These complicated products offer the exact opposite return of an index multiplied by a factor of either 2 or 3, but this performance is only for one day. Basically, if the S&P drops 5%, an inverse ETF goes up 5%, a 2X Leveraged ETF goes up 10%, and a 3X Leveraged ETF goes up 15%. However, when these products are held beyond one day, their performance can be wildly different than what most investors would expect.

The leverage creates a characteristic that is called volatility drag. It is very similar to compounding and causes the longer term performance to be much higher or lower than the underlying index. These products have a place, but only the most knowledgeable active managers should use them. I’m not convinced that they reduce risk and believe, that for most investors, they dramatically increase portfolio risk!

Evidently, one major brokerage firm agrees. Here’s the article from the Wall Street Journal.

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Finra’s ETF notice angers ICI, firms – Investment News

July 13, 2009

Finra’s ETF notice angers ICI, firms – Investment News

I recently read and reviewed Martin Weiss’s bestselling investment book, The Ultimate Depression Survival guide on Amazon. To read the review, click the link in the blogroll entitled, Paul’s Reviews of Books on Amazon.

My concern with the investment advice offered in this book is the use of leveraged ETF’s, which FINRA recently deemed unsuitable for individual investors. This article from Investment News describes FINRA’s decision and the reaction of brokers, leveraged ETF providers, and advisors. These ETF’s appear to offer a simple solution to a falling market, but they are actually very complex and require continuous monitoring. By necessity, any discussion of leveraged ETF’s is technical.

My main point is that the DIY, do it yourself, investor should avoid leveraged ETF’s and, quite frankly, I’m not sure most advisors should utilize these funds either.

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